What Is a Rate Lock and How Does It Affect My Loan?

Almost anybody who has ever purchased a home, or refinanced a mortgage has probably heard of a ?rate lock? or ?locking the rate.? However, what does it mean to you, the borrower, and how can it affect your financing? Well, let?s do a bit of the back-story first.

This Might Not Make Me Any Friends But…The Higher the Rate You Pay, the More the Broker Makes

Locked In or Out?

Most mortgage brokers and mortgage bankers get paid on something called yield spread premium (YSP), or service release premium (SRP). These terms are essentially interchangeable, and they represent the same thing, only differing in that if a loan is brokered or banked. It?s same end result, only differing in how the loan is delivered to the investor. For more on how rates are determined, see my article called What Causes Mortgage Rates to Move.

So here?s the juicy part: the higher the rate you get, the more the broker makes on it! This is something many would like you not to know. For example, on a 30-day lock at 5.0%, I might get a ?rebate? of 1.0% of the loan amount. For that same borrower, I might get YSP of 2.0% at 5.5%. Now, this is not a ?linear? relationship. Because of the way the markets work, there are usually a couple of ?hiccup? lines, or ?sweet spots? where pricing is better or worse. And, more importantly, the SRP or YSP can vary greatly from one borrower to the next, based on risk factors such as loan-to-value (LTV) or credit score. For a thorough explanation, see my article called Why You Might Not be Able to Get a 5% Mortgage. A person with a 745 score at 60% LTV would be able to get a better rate than somebody with a 700 score at 80% LTV. And the loan amounts factor in, too. There are differing guidelines for different lenders, but the rate on a $80,000 loan would be higher than for a $150,000 loan, and a loan over $250,000 or $300,000 would likely get an even better rate. And condos are worse?a lot worse. I like to be transparent to my borrowers, and I typically make around 1-1.5% on most of my loans.

What If the Closing Is Delayed?

So, if we take our above example of 5.0% on a 30-day lock paying the mortgage broker 1%, it might pay a little more on a 15-day lock, maybe 1.25%. It might be a little less on a 45-day lock, maybe around .75%, or .5% on a 60-day lock. You probably could only do a 15-day lock on a loan that was already submitted and approved, but you might have to do a 45 or 60 day lock for a purchase that isn?t closing for 30-45 days. And with the way underwriting has been going these days; you generally need to lock for a longer period, as loans aren?t going though very fast. And you have to pay to extend locks. For instance, let?s say the loan took longer to process, or a closing got pushed back. If we locked it for 30 days, we?d probably have to pay .25% to get a 5 or 10 day extension. Many places have a minimum of 1% per loan, so in this case we might have to raise the rate, or add a quarter point (.25% of the loan amount) to get there. This is what we are talking about when we say ?blowing a lock??the lock has past its expiration date, and the loan has not funded, or extending a lock so you don?t blow it.

What If Rates Get Better Before Closing?

You probably know that if rates go up, but you have your loan locked, you are essentially ?protected?, and that you will get a lower rate than anybody who applies after you did, assuming your loan actually clears underwriting and closes. If something unexpected pops up, and the lender asks for conditions you can?t provide, we might have to take the loan to a different lender, and then the rate would be higher, in accordance with the market.

But let?s say you loan was locked at 5.5% (paying the broker 1%), and rates go down after you lock?for example the current market is 5.0% paying the broker 1%. You should be able to get 5%, right? Well, not necessarily? Here we may have a couple options, none of them very good for the mortgage broker. One option, depending on the lender, might be to ?float down? the rate. We keep the loan with the same lender, and adjust the rate. But they don?t just give it to you. If we were submitting a new loan at 5.0%, we could get 1%, but we already locked it at 5.5% paying 1%. If we float down, we have to pay for it, just like an extension. In this scenario, they might give us 5.0% paying .625% because we have to pay .375% for the float down. So, if the broker has to get 1%, you?d have to pay .375% in points. The other option, which isn?t always an option, is to cancel the loan and take it to another lender. If it?s a retail operation, this might not be an option, or if there were any unusual circumstances that might prevent your loan from getting approved at a new lender, moving it may not make sense.

So…What Is a Rate Lock? It’s Kind of a Big Deal.

Locking a loan basically means that the bank or lender has earmarked a given amount of money at a given rate to be delivered. They have earmarked this with investors or with Wall Street. The interest rate and YSP are determined by Wall Street, and depending on where the markets are, they will buy a loan at a given price when it?s locked.

And it?s kind of a big deal. A lender would rather have a broker send in a file, and they spend the time and energy of the underwriters, processors, appraisal reviewers, etc. and not have the loan close than to have a lock that doesn?t get delivered. Lenders sometimes cut off brokers from locking, or from doing business with them altogether, if they lock too many loans that don?t close. They likely wouldn?t cut a broker off for just sending them loans that end up not closing. This might be one of the reasons why we couldn?t just pull the loan and go elsewhere if rates go down, as I mentioned above.

That is why it is the mortgage broker or banker?s job to explain to the customer what a lock is, and what it means to lock. A good mortgage professional understands the market and how it moves, and should be able to make good recommendations to his or her clients on whether to lock or float (not lock) a loan, but the decision should be borrower?s. And what it comes down to is essentially a gamble; you agree to a rate, and lock it, but if the market improves, you can?t necessarily take advantage of it. If you thought you had a great rate two weeks ago, it should still hold true today. Sure, hindsight is always 20/20, but if you are taking your rate from 6.5% down to 5.25%, then that is beneficial, and you shouldn?t be kicking yourself because your friend or neighbor got 5.0%.

Essentially, You Have Agreed to a Price

An analogy might be if you bought a new car for $25,000, and three months later the same car is on sale for $22,000. You can?t walk in and demand $3,000, or trade your now 3-month old car in for the new one. Markets change, supply and demand changes, and the price you pay for anything from mortgages to milk can change. All you can do is make what is a good decision at the time.

We would like to thank Rohit Gowaikar for sharing today’s photo via the Creative Commons License.

About Brad Walbrun

Brad Walbrun grew up in northeastern Wisconsin, moving to Chicagoland over a decade ago, and never to return, although he remains an avid Packer fan. He is married, with 3 children, living in Schaumburg. Brad's passions are fitness, MMA, and mortgages. He has been in the mortgage industry since before the refi boom, for almost 10 years now. You can reach Brad at (847) 975-4440 or bradwalbrun@hotmail.com.

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